Ethereum is a big deal, in case you haven’t heard. It’s a community-run technology powering the cryptocurrency, ether (ETH) and thousands of decentralized applications. It’s the foundation for the future of finance, along with many promising DEFI (decentralized finance) applications.
When Bitcoin (BTC) first caught my attention, it was described to me as being similar to the invention of “email” in the dawn of the internet era. A first use case example in the new era of the internet evolution referred to as Blockchain technology. Bitcoin showcased many important features as a store of value and a currency, but most importantly the ability to make electronic payments in a decentralized, transparent and trustless manner. Probably a bit more revolutionary than the humble email.
Ethereum aims to achieve far more, thanks to the groundwork laid by Bitcoin. Through its visionary, Vitalik Buterin, the Ethereum community set out an ambitious goal to overhaul the financial system, and the way its governed, through the use of smart contracts. We are talking about the entire financial services sector from asset management to insurance to lending & credit. This is not disruption, this is evolution, the stuff Cypherpunk’s dream about.
Sound’s crazy right? Well you better believe it. Ethereum’s masterstroke was to become the first, most widely used and adopted smart contract platform. This “platform” allowed developers to create their own applications, tokens and businesses, all built on top of the Ethereum blockchain. Many other Smart Contract platforms have emerged since, however none come close to it, in terms of usage, market value and most importantly community.
Community is an often overlooked attribute for a successful enterprise. The internet has allowed us to become more connected than ever and the 2020 pandemic forced us to spend more time online than ever. Creating, connecting and consuming. This was an important catalyst for blockchain technology.
In early 2021, we saw the community effect again with the infamous Gamestop short squeeze that was ignited by the reddit r/wallstreetbets community. After record increases in GME stock price, market makers and brokers imposed limits on buying the share. On January 28th, multiple brokerages, including Robinhood, halted the buying of GameStop and other securities, later citing their inability to post sufficient collateral at clearing houses to execute their clients’ orders. This is a clear example of an inefficient centralized and biased financial system.
Introducing DEFI
Decentralized Finance or DEFI, is a blockchain sector that is turning the financial services sector on its head. By merging traditional financial products and decentralized technology, DEFI has enabled anyone to participate in a wide range of financial transactions, previously not available to them. The most successful DEFI applications(DAPPS) to date are all built on Ethereum .
DEFI has the ability to change the way we invest, borrow and lend money. Let me give you an example:
Lets say you are a young entrepreneur in your 20’s or 30’s who wants to buy a car for $10,000. You may have some money saved in the bank and have an investment in Bitcoin or stocks. You decide to approach your bank for a loan as you aren’t too keen to draw on your savings and you don’t want to sell your investments.
Your banker asks for your proof of income (which may be variable as an entrepreneur), checks your credit record/history and conducts a few other due diligence checks. You submit your 20+ page application and nervously await the decision from your bank for your $10,000 loan approval.
You get rejected. The bank lenders decide you are only good for $5000, due to your “risk profile” and credit history. You reluctantly accept the offer, sign the paperwork and await payment into your account, which may take several days. You sell some of your investments and savings to cover the difference and buy your dream car. This is the old way.
With DEFI this transaction looks completely different. DEFI applications, like Compound or AAVE, allow users to deposit their Cryptoassets (Bitcoin or Ether), as collateral and instantly access 80% of the asset’s value as a loan (subject to lending terms).
This transaction has 4 major benefits:
- It allows the underlying investments to grow without sacrificing any future potential gains.
- Does not trigger a tax event as the underlying investments are not sold to fund the shortfall.
- Allows for a trustless transaction whereby your personal details and financial history are not required or shared.
- By providing collateral, you are also entitled to earn interest on the assets deposited with DEFI.
There are several important risks to consider in the above example. These include transaction costs, penalty fees (if collateral values fall below required amounts), smart contract code errors, exploits and others. We are in the dawn of a new industry and there will be stumbling blocks along the way and some expensive lessons have already been learnt. These growing pains are found in any fast growing sector. Don’t let them distract you.
The takeaway here is simple. DEFI enables more inclusive access to financial products with added benefits. No banks, no documents, no long waits, no uncertainty.
The above example uses Cryptoassets as collateral, which may not be relevant to everyone, but in the not-too-distant future this could include listed stocks, bonds or any asset that can be securely captured on a blockchain. Even Gold!
When this happens, we expect the traditional finance and Crypto industry to merge and drive DEFI adoption and growth for the next decade. It’s already happening and the best part is you can watch it all unfold live, on the blockchain. No need to wait for quarterly reports or annual financial statements to get an insight into what may be happening in a particular company or sector. We are watching the the financial industry evolve one line of code at a time, and it’s truly exciting.
This is the future of finance, and it’s built on Ethereum.
